“There is a need to moderate the demand for gold imports, as ensuring external sector’s stability is critical,” exhorts the report, released by the Reserve Bank of India (RBI) in January 2013, of the Working Group to study the issues related to gold imports and gold loans by NBFCs. India imported a staggering quantity of 1,112 tonnes of gold at a cost of $61 billion in 2012-13. That means India now consumes about one quarter of the total global supplies of gold. This large import bill contributes about 30 per cent of the trade deficit. The current account deficit (CAD) has deteriorated to 4.2 per cent of the GDP. Normally, CAD of 2 per cent is regarded as safe and anything above this level is unsustainable. This gave the warning signal and the Reserve Bank of India constituted a Working Group, which submitted its report in August 2012.
In a way, the problem of gold imports assuming alarming proportions is our own creation. Prior to 1992, there was a ban on the import of gold. The government of India started liberalizing the import of gold from 1992 and permitted its import by certain nominated agencies, viz Minerals and Metals Trading Corporation, Handicrafts and Handlooms Export Corporation, State Bank of India etc. Intoxicated with the market theology of the 1990s, our policy makers have pushed India to what one might call the “gold cliff.” The Dr. Tarapore Committee on capital account convertibility also recommended in 1997 that it was essential to liberalise the import of gold. WTO did not ask us to liberalise the import of gold. Even the IMF, which was a strong advocate of full convertibility, chastened by empirical experience, started to soft-pedal the issue. But those were the heady days of market theology in India. Even when gold imports were modest, at about $5 billion, I had warned that liberalizing gold imports was a blunder and alas, the warning has proved to be prophetic. A poor country, which continues to be the abode of the largest number of underfed and undernourished persons in the world, cannot afford to definancialise and invest enormous amounts of $60 to $70 billion in an unproductive asset like gold. At long last, wisdom has dawned on the RBI. If left unchecked, gold imports would play havoc with the economy, disrupting growth.
Dr. K.U.B. Rao, chairman of the RBI Working Group, should be congratulated on assembling a mass of data on related issues and providing an excellent analysis of the issues involved. I am sure the report will remain as the standard reference work on gold for years to come.
What are the factors underlying the spurt in demand for gold? The price of gold, rural income distribution, the quantum of black money, the rate of return on alternate financial assets and the general price level. Returns on gold investment have outperformed other comparable assets in three of the last five years.
Here one important distinction needs to be made between returns on gold to an individual investor and returns to the community as a whole. While individuals do derive benefits from investing in gold, for the community the benefits are nil because gold does not add to the stream of national income. In this sense, it is a dead investment.
How does one go about reducing the import of gold? The conventional method is to raise the import duties on gold. In fact, the finance minister, in a statement made on January 2, 2013, indicated his intentions to do so. The Working Group, however, is sceptical about the measure producing the desired result because gold imports in India are price inelastic as the empirical experience shows. Nonetheless, there is justification for raising the import duties both to disincentivise gold imports and also add some revenue to the exchequer.
The Working Group has shown remarkable insight into the problem when it states: “What is critical is to ensure provision of real higher returns to investors through various financial savings products. What is also relevant is the need for banks to introduce new gold-backed financial products that may reduce or postpone the demand for gold imports. The Working Group believes that providing a real rate of higher return to investors through alternative investments holds the key to reducing the excessive demand for gold. Meanwhile, “there is also a need to increase monetization of idle gold stocks in the economy for productive purposes.” The Working Group has offered a number of concrete proposals towards achieving this objective. The RBI would do well to act on these proposals promptly.
Among the new gold-backed financial products proposed designed to reduce the demand for physical gold are: Modified Gold Deposit Scheme (gold taken as a deposit is recycled for meeting domestic demand and given back at the time of maturity); Gold Accumulation Plan (the product is a saving plan catered to even small buyers of gold in which the gold imports are deferred till the time of actual delivery of gold); Gold Linked Account (the entire transaction takes place outside India and the import of gold is not involved); and Gold Pension Product (the customer surrenders gold to the bank on agreement to receive streams of monthly pension till his death).
Other important proposals put forward by the working group relate to recycling of domestic gold and monetisation of gold. Temples in India hold large quantities of gold in the form of jewellery. If the recent discovery of gold treasury of the Padmanabha temple in Thiruvananthapuram is any guide, private holdings of gold add to astronomical figures. Perhaps the heap of gold pooled from all temples may be larger than the pooled gold reserves of Central Banks of major countries in the world. It is in this sense that India is said to be a rich country inhabited by poor people. Similarly, scrap gold of some 300 tonnes is generated every year. It would be good to devise a modus operandi to channel at least a part of this gold into the formal financial system.
Perhaps the most important proposal in this context is the setting up of a bullion corporation or Gold Bank. The purpose of the Gold Bank is to offer a “backstop facility” to provide refinance to institutions lending against the collateral of gold. It can also undertake retailing functions in gold, including pooling of idle gold. The Gold Bank can make purchases and sales of gold: it can issue gold bonds and collect gold stocks. It can mobilise domestic private gold holdings and deploy them for productive uses. In fact, one could think in terms of the Gold Bank employing agents – on the lines of banking correspondents – to reach potential customers in not only urban, but rural areas also. Such operations on a countrywide scale hold out great potential for mobilising domestic private gold.
Instead of the usual stock answer to ban gold imports, the Working Group has provided various alternatives to achieve the objective. Because a ban may drive gold imports to unofficial channels. In this sense, the alternatives recommended by the Working Group offer a lasting and more productive solution to tackle the problem of alarming levels of gold imports. The ball is in the RBI court now and one hopes it will respond promptly.
DR.N.A. MUJUMDAR
